Pay-to-Play in America, Part 4: The SEC's Proposal for Regulating Pay-To-Play

The first three parts of this series describe various facets of the never-ending "pay-to-play" cycle. Money managers contribute to the campaigns of elected officials, who then award public pension business to the money managers, who make more contributions, are awarded more business and so on.

Pay-to-Play in America, Part 1

Pay-to-Play in America, Part 2: The Subtle Side of the Game

Pay-to-Play in America, Part 3: 'Money Rarely Raises Its Voice'

Pay-to-Play in America, Part 4: The SEC's Proposal for Regulating Pay-To-Play

In August 1999, the Securities and Exchange Commission, which is responsible for regulating money managers, proposed to prohibit money managers from engaging in pay-to-play.

As often happens with universally popular causes, politicians and industry representatives unanimously condemned pay-to-play and applauded the rule's purpose -- and then proceeded to question every dotted "i" and crossed "t" until the rule was crushed under the weight of the unattainable perfection they demanded.

The Enemy of the Good

The SEC's proposal is elegantly simple. It would require that money managers give up any compensation they received for managing public money for two years after the firm, its executives or agents made a campaign contribution to an elected official or candidate who could have influenced the selection of the money manager.

But doing the right thing, when it involves upsetting accepted practices in an industry, is never that simple. Unable to attack the rule on principle, critics sniped unrelentingly at its inevitable imperfections, proving the adage that the perfect often can be the most powerful enemy of the good.

Critics charged that the rule was too broad because it applied to too many contributors, and too narrow because it did not include money managers not regulated by the SEC, such as banks.

The rule violated the First Amendment, despite the fact that courts expressly rejected the same arguments about a similar rule only the year before.

The rule encroached on the jurisdiction of the Federal Election Commission, even though it applied only to money managers and falls squarely within decades of judicial interpretations of the scope of the SEC's authority.

The rule was unfair because it would not always apply equally to all candidates competing for the same post. The rule would have prohibited governors, such as George Bush and New Jersey's Christine Todd Whitman (now head of the Environmental Protection Agency) running for federal office from collecting contributions from money managers who sought business from their states, but would have left their opponents unaffected.

The rule was overbroad because it applied regardless of whether the contributor could be proved to have intended the contribution to win business. Yet it is precisely the secret nature of pay-to-play practices, and the impossibility of proving intent, that necessitates a ban against all contributions.

Campaign contributions need no instructions to have their intended effect -- money talks.

Most frequently, and most disingenuously, critics argued a lack of evidence of pay-to-play abuses -- knowing full well that the SEC could not afford the political fallout that would result if it aggressively publicized insinuations of legal bribery of hundreds of elected officials.

In fact, the evidence of pervasive pay-to-play practices is overwhelming, as substantiated in dozens of articles in public files at the SEC's Washington, D.C., headquarters. If you can't make the pilgrimage to the capital, an abstract of the files is available at Fund Democracy's Web site.

A Record of Success

Critics are notably silent about the success of the rule on which the pay-to-play proposal is modeled, Rule G-37. That rule, in effect since 1994, prohibits municipal bond underwriters from contributing to the campaigns of elected officials who may influence the award of bond underwriting contracts. The rule is widely credited with cleaning up the municipal bond industry.

The rule's disciplining effect is pronounced. A Morgan Stanley employee violated the rule with a contribution to Massachusetts Governor William Weld and the firm was barred from doing business with the state for two years. A.G. Edwards had to withdraw from underwriting bonds first for Texas and later for Missouri because of separate G-37 violations.

Another measure of Rule G-37's success has been its incidental effect on pay-to-play in the money manager arena. State treasurers and other elected fiduciaries of municipal pension funds have seen campaign contributions from municipal underwriters dry up. So they've turned to money managers and lawyers doing business for the pension funds to make up the difference.

After Connecticut State Treasurer Joseph Suggs lost his re-election bid, he inadvertently left behind confidential files that discussed strategies for making up for lost municipal underwriter contributions, asking "What alternative sources ... can we access? (unregulated by SEC)."

Because contributions from money managers were "unregulated by SEC," they were a natural target. Suggs admitted that he pursued these contributors because of G-37.

North Carolina State Treasurer Harlan Boyles, who relied heavily on municipal underwriters to finance his campaigns, fought G-37. Firms managing state pension funds made up the shortfall to the tune of $40,000 in contributions.

Matt Fong's predecessor as California State Treasurer, Kathleen Brown, raised more than $450,000 from municipal underwriters with stakes in state bond deals. Fong raised less than $50,000 from the same group, but made up some of the difference by raising $275,000 from bond lawyers involved in bond deals, and thousands more from firms managing public pension money.

An Opportunity for Action

So it's not just the success of its model -- Rule G-37 that argues for the SEC's money manager pay-to-play rule. It's also the increasing pressure Rule G-37 has created on public officials to look to money managers for campaign contributions.

Fortunately, some jurisdictions have implemented their own rules. Money managers are subject to limitations on their ability to make contributions to public pension officials in Connecticut, Vermont and California.

The risk of a fund-by-fund or state-by-state approach, however, is that it will be impossible for money managers to comply with dozens of rules, each with different record-keeping and other requirements. The pay-to-play problem begs for an across-the-board, federal solution.

Unfortunately, the federal pay-to-play rule has no natural constituency. Incumbent politicians want to maintain all potential sources of campaign money. Money managers who benefit from pay-to-play like the status quo, and those who don't benefit risk retaliation if they criticize the system. Indeed, almost all comments by money managers criticizing pay-to-play have been made anonymously.

So the rule's only natural constituency is you. Write the SEC, contact your U.S. Senators and Representatives, and complain to your state and local pension boards (you can visit Fund Democracy's Web site for addresses and a guide to action). Act now -- it's your money.